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Inventory Control
Chapter 17
Inventory System Defined
Inventory Costs
Independent vs. Dependent Demand
Single-Period Inventory Model
Multi-Period Inventory Models: Basic
Fixed-Order Quantity Models
Multi-Period Inventory Models: Basic
Fixed-Time Period Model
Miscellaneous Systems and Issues
OBJECTIVES
17-3
Inventory System
Inventory is the stock of any item or
resource used in an organization and
can include: raw materials, finished
products, component parts, supplies,
and work-in-process
An inventory system is the set of
policies and controls that monitor levels
of inventory and determines what levels
should be maintained, when stock
should be replenished, and how large
orders should be
17-4
Purposes of Inventory
1. To maintain independence of
operations
2. To meet variation in product demand
3. To allow flexibility in production
scheduling
4. To provide a safeguard for variation in
raw material delivery time
5. To take advantage of economic
purchase-order size
17-5
Inventory Costs
Holding (or carrying) costs
Costs for storage, handling,
insurance, etc
Setup (or production change) costs
Costs for arranging specific
equipment setups, etc
Ordering costs
Costs of someone placing an order,
etc
Shortage costs
Costs of canceling an order, etc
17-6
E(1
)
Independent vs. Dependent Demand
Independent Demand (Demand for the final end-
product or demand not related to other items)
Dependent
Demand
(Derived demand
items for
component
parts,
subassemblies,
raw materials,
etc)
Finished
product
Component parts
17-7
Inventory Systems
Single-Period Inventory Model
One time purchasing decision (Example:
vendor selling t-shirts at a football game)
Seeks to balance the costs of inventory
overstock and under stock
Multi-Period Inventory Models
Fixed-Order Quantity Models
Event triggered (Example: running out of
stock)
Fixed-Time Period Models
Time triggered (Example: Monthly sales
call by sales representative)
17-8
Single-Period Inventory Model
u o
u
C C
C
P
P
This model states that we
should continue to increase
the size of the inventory so
long as the probability of
selling the last unit added is
equal to or greater than the
ratio of: Cu/Co+Cu
17-9
Single Period Model Example
Our college basketball team is playing in a
tournament game this weekend. Based
on our past experience we sell on average
2,400 shirts with a standard deviation of
350. We make $10 on every shirt we sell
at the game, but lose $5 on every shirt not
sold. How many shirts should we make
for the game?
C
u
=$10 and C
o
= $5; P $10 / ($10 + $5) = .667
Z
.667
= .432 (use NORMSDIST(.667) or Appendix E)
therefore we need 2,400 + .432(350) = 2,551 shirts
17-10
Multi-Period Models:
Fixed-Order Quantity Model Model Assumptions (Part 1)
Demand for the product is constant
and uniform throughout the period
Lead time (time from ordering to
receipt) is constant
Price per unit of product is constant
17-11
Multi-Period Models:
Fixed-Order Quantity Model Model Assumptions (Part 2)
Inventory holding cost is based
on average inventory
Ordering or setup costs are
constant
All demands for the product will
be satisfied (No back orders are
allowed)
17-12
Basic Fixed-Order Quantity Model and Reorder Point Behavior
R = Reorder point
Q = Economic order quantity
L = Lead time
L
L
Q Q Q
R
Time
Number
of units
on hand
1. You receive an order quantity Q.
2. Your start using
them up over time.
3. When you reach down to
a level of inventory of R,
you place your next Q
sized order.
4. The cycle then repeats.
17-13
Cost Minimization Goal
Ordering Costs
Holding
Costs
Order Quantity (Q)
C
O
S
T
Annual Cost of
Items (DC)
Total Cost
Q
OPT
By adding the item, holding, and ordering costs
together, we determine the total cost curve, which in
turn is used to find the Q
opt
inventory order point that
minimizes total costs
17-14
Basic Fixed-Order Quantity (EOQ) Model Formula
H
2
Q
+ S
Q
D
+ DC = TC
Total
Annual =
Cost
Annual
Purchase
Cost
Annual
Ordering
Cost
Annual
Holding
Cost
+ +
TC=Total annual
cost
D =Demand
C =Cost per unit
Q =Order quantity
S =Cost of placing
an order or setup
cost
R =Reorder point
L =Lead time
H=Annual holding
and storage cost
per unit of inventory
17-15
Deriving the EOQ
Using calculus, we take the first derivative of
the total cost function with respect to Q, and
set the derivative (slope) equal to zero,
solving for the optimized (cost minimized)
value of Q
opt
Q =
2DS
H
=
2(Annual Demand)(Order or Setup Cost)
Annual Holding Cost
OPT
Reorder point, R = d L
_
d = average daily demand (constant)
L = Lead time (constant)
_
We also need a
reorder point to
tell us when to
place an order
17-16
EOQ Example (1) Problem Data
Annual Demand = 1,000 units
Days per year considered in average
daily demand = 365
Cost to place an order = $10
Holding cost per unit per year = $2.50
Lead time = 7 days
Cost per unit = $15
Given the information below, what are the EOQ and
reorder point?
17-17
EOQ Example (1) Solution
Q =
2DS
H
=
2(1,000 )(10)
2.50
= 89.443 units or
OPT
90 units
d =
1,000 units / year
365 days / year
= 2.74 units / day
Reorder point, R = d L = 2.74units / day (7days) = 19.18 or
_
20 units
In summary, you place an optimal order of 90 units. In
the course of using the units to meet demand, when
you only have 20 units left, place the next order of 90
units.
17-18
EOQ Example (2) Problem Data
Annual Demand = 10,000 units
Days per year considered in average daily
demand = 365
Cost to place an order = $10
Holding cost per unit per year = 10% of cost
per unit
Lead time = 10 days
Cost per unit = $15
Determine the economic order quantity
and the reorder point given the following
17-19
EOQ Example (2) Solution
Q =
2DS
H
=
2(10,000 )(10)
1.50
= 365.148 units, or
OPT
366 units
d =
10,000 units / year
365 days / year
= 27.397 units / day
R = d L = 27.397 units / day (10 days) = 273.97 or
_
274 units
Place an order for 366 units. When in the course of
using the inventory you are left with only 274 units,
place the next order of 366 units.
17-20
Fixed-Time Period Model with Safety Stock Formula
order) on items (includes level inventory current = I
time lead and review over the demand of deviation standard =
y probabilit service specified a for deviations standard of number the = z
demand daily average forecast = d
days in time lead = L
reviews between days of number the = T
ordered be to quantitiy = q
: Where
I - Z + L) + (T d = q
L + T
L + T
T+L d
i 1
T+L
d
T+L d
2
=
Since each day is independent and is constant,
= (T+ L)
i
2